Holmes v. Summer – Fiduciary Duties of Real Estate Broker

In the recent decision in Holmes v. Summer (Oct. 6, 2010) 188 Cal.App.4th 1510, the court discussed the fiduciary obligations owed by a real estate broker in a sales transaction. The facts were not difficult.

The broker represented the seller. According to the opinion, “the buyers and the seller agreed to the purchase and sale of a residential real property for the price of $749,000 . . . The counter offer did not disclose that the property was subject to three deeds of trust totaling $1,141,000 . . . Unbeknownst to the buyers, the property was subject to a first deed of trust in the amount of $695,000, a second deed of trust in the amount of $196,000 and a third deed of trust in the amount of $250,000, for a total debt of $1,141,000.”

Thus, the amount offered was $392,000 less than the debt encumbering the property. When the sale did not close for the price in the listing agreement, the buyer’s sued the listing agent.

Stop here. How could the buyers have any expectancy damages? The debt was $1.1 million, while the offer was $750,000. The buyers expected to pay $750,000, while the debt was $1.1 million. The buyers did not lose the benefit of their bargain, as they did not offer enough to purchase the property.

Instead, the buyers could claim only reliance damages, being amounts they reasonably expended in reliance on the contract. “According to the buyers, after they signed the deal with the seller, they sold their existing home in order to enable them to complete the purchase of the seller’s property. Only then did they learn that the seller could not convey clear title because the property was overencumbered.”

However, didn’t the buyers receive a preliminary title report listing the encumbrances? If so, how could the buyers claim reasonable reliance, when they had full disclosure of the encumbrances, albeit from a third party? From the opinion, it seems that the court feels that the broker is on the hook, regardless of future information learned by the buyer.

According to the opinion, “The case before us presents the interesting question of whether the real estate brokers representing a seller of residential real property are under an obligation to the buyers of that property to disclose that it is overencumbered and cannot in fact be sold to them at the agreed upon purchase price unless either the lenders agree to short sales or the seller deposits a whopping $392,000 in cash into escrow to cover the shortfall.”

OK, that’s one way to frame the issue, although the court will proceed to explain that brokers are required to police the real estate market. “Under the facts of this case, the brokers were obligated to disclose to the buyers that there was a substantial risk that the seller could not transfer title free and clear of monetary liens and encumbrances.”

Duties of Agent

As explained by the court, “It is now settled in California that where the seller knows of facts materially affecting the value or desirability of the property which are known or accessible only to him and also knows that such facts are not known to, or within the reach of the diligent attention and observation of the buyer, the seller is under a duty to disclose them to the buyer. When the seller’s real estate agent or broker is also aware of such facts, he [or she] is under the same duty of disclosure.”

The court continued. “Despite the absence of privity of contract, a real estate agent is clearly under a duty to exercise reasonable care to protect those persons whom the agent is attempting to induce into entering a real estate transaction for the purpose of earning a commission.”

“The allegation here is that the brokers had a duty to disclose the liens before the buyers signed the agreement. Only then could the buyers weigh the risks of entering into an agreement, and preparing their finances and related affairs to facilitate completion of the purchase, considering there was a significant possibility the transaction would fall through. Disclosing the liens only after the buyers had entered into the escrow failed to protect them in this context.”

“Here, the buyers say that they sold their existing home in order to purchase the seller’s property and were damaged when the seller failed to convey title . . . To impose a duty on the brokers here to disclose information alerting the buyers that the sale was at high risk of failure would be to further the purpose of protecting buyers from harm and providing them with sufficient information to enable them to wisely choose whether to enter into the transaction.”

Reliance by the Buyers

“The buyers expected, based on the standard form documents they signed, as representative of industry standards, that they would receive a preliminary title report after their offer was accepted and escrow was opened. They were given no reason to believe that they needed to pay for a title search before even making an offer on the property.”

“Just because a purchaser has constructive notice of a matter of record, this does not eliminate all of the duties of disclosure on the part of a seller or its agents. In the matter before us, assuming a title search would have revealed the existence of deeds of trust against the property, this does not mean that constructive notice of those recorded deeds of trust would necessarily preclude an action based on the alleged breach of a duty to disclose.”

“The rule we articulate in this case is simply that when a real estate agent or broker is aware that the amount of existing monetary liens and encumbrances exceeds the sales price of a residential property, so as to require either the cooperation of the lender in a short sale or the ability of the seller to put a substantial amount of cash into the escrow in order to obtain the release of the monetary liens and encumbrances affecting title, the agent or broker has a duty to disclose this state of affairs to the buyer, so that the buyer can inquire further and evaluate whether to risk entering into a transaction with a substantial risk of failure.”

Duty of Confidentiality

“Turning now to moral blame, we observe that California cases recognize a fundamental duty on the part of a realtor to deal honestly and fairly with all parties in the sale transaction. Surely a sense of rudimentary fairness would dictate that buyers in a case such as this should be informed before they open escrow and position themselves to consummate the same that there is a substantial risk that title cannot be conveyed to them . . . Both the policy of preventing future harm and considerations of moral blame compel the imposition of a duty on the part of a realtor never to allow a desire to consummate a deal or collect a commission to take precedence over his fundamental obligation of honesty, fairness and full disclosure toward all parties.”

“At a minimum, the brokers did not act fairly towards these residential buyers when signing them up for a real estate purchase the brokers had reason to know was a highly risky proposition. Since the brokers had a duty to act fairly towards the buyers, and fairness under the circumstances dictated disclosing that either lender approval or a substantial seller payment was required to close escrow, the portion of Civil Code section 2079.16 upon which the brokers rely did not exempt them from the duty to disclose.”

“To recapitulate, in balancing the factors [ ], we conclude that the brokers in the matter before us had a duty to disclose to the buyers the existence of the deeds of trust of record, of which the brokers allegedly were aware . . . so the buyer can make an informed choice whether or not to enter into a transaction that has a considerable risk of failure.”

“By so holding, we do not convert the seller’s fiduciary into the buyer’s fiduciary. The seller’s agent under a listing agreement owes the seller a fiduciary duty of utmost care, integrity, honesty, and loyalty.” Although the seller’s agent does not generally owe a fiduciary duty to the buyer, he or she nonetheless owes the buyer the affirmative duties of care, honesty, good faith, fair dealing and disclosure, as reflected in Civil Code section 2079.16, as well as such other nonfiduciary duties as are otherwise imposed by law.